Investing in my sister's baking business

[moda0306]

As a tax accountant I've seen Operating Agreements, and there's so much flexibility today.  You could do an LLC, and have a "Preferred return" type of arrangement where you get the first $XXX of profits to get you to 6% yield, and then X% of the profits after that.  You could arrange it so you have NO decision-making power in this arrangement, and are a fully passive investor.  An LLC is basically a tool that lets you turn almost any profit-making arrangement into an entity that reflects that arrangement for both legal, tax, and distributional purposes.

If you talk to a good lawyer with a good head for BUSINESS, not just law, he should be able to help you out immensely with deciding how your goals are aligned with the operating agreement. 

One thing to think of, too, is that some of this intrafamily stuff can get a bit hairy and could harm the relationship, though I'm sure you're more than aware of the nature of your relationship with your sister, and whether you trust her, etc.  Ownership can be a double-edged sword.  By the time you are done getting a $4,000 loan paid back at 5-8% or whatever, you might be glad you aren't still attached to the business.  Often, payout won't happen until she liquidates the business.  That may not be at a convenient time for you (though $4,000 is hardly a huge amount of money).

Also, consider an SBA loan.

[craigr]

A couple things:

1) Don't get put on the hook for more than your investment (e.g. don't co-sign any loans). Also don't commit to any future money right now. You can do it in the future if you want, but you don't want to be seen as the fall-back option if there is money trouble in the business such as: "But you promised me that you'd loan me more, remember?"

2) Loaning money to friends/family has a way of ruining relationships if it doesn't work. I would not make it a loan as much as an investment that is paid back over time with interest and if not paid back, oh well. But be very clear on this with yourself and others involved about what happens if things don't work. I would also temper what advice I was giving on business operations to not crowd her and stress yourself out at the same time.

[MediumTex]

I would probably just say pay me back $5,000 one or two years from now.

$4,000 is IMHO not enough money to justify spending much time on accountants and lawyers.  I think a handshake for a deal like that should be fine, and if you are concerned that a handshake won't be sufficient I probably wouldn't put any money into the business at all.

[moda0306]

MT's right... I wasn't thinking of materiality.

[Gumby]

At least encourage her open up a crowd funding page (on a site like Indiegogo.com). Rather than seek out a few big loans, she could do pretty well with crowd funding to achieve some short term goals. I know people who opened up a cheese shop and they sent an invite to everyone they knew to crowdfund their store on one of those sites. They raised about $1,500 dollars. If you gave $25, you got some cheese. If you gave $50 you got more cheese, etc.

Of course, I gave $25 and never got any cheese — despite a few gentle reminders. But, that's the beauty of the unregulated crowd funding market. One could literally defraud people out of thousands of dollars in small "investment" donations and use the money for a vacation.

[moda0306]

Gumby,

Does the cheese represent interest, or payment of principal in full?

Seems like when you get money for cheese that's a sale like any other.

[Pointedstick]

Having done enough of it myself (and also watching a lot of Judge Judy, I'm not gonna lie), has taught me to never loan money to family and friends. I just make it a gift, and if they decide to give you any money in the future, well that's nice. But if you've psychologically counted the money as a loan, and the person can't or doesn't pay, you've got not only a serious financial problem, but also a serious relationship problem. It can destroy your respect for that person and drive a massive wedge between you.

[hoost]

I have to echo a few others here and then go a little farther to say that even as an equity investment, it may not be worth it in terms of the potential strain on your relationship.  I'd say if you want to help, give her a gift and don't expect anything in return.  Who knows how she will run the business; do you want that to affect your relationship together?  Seems like a lot of personal/emotional risk for very little financial gain.

[Lone Wolf]

Having done enough of it myself (and also watching a lot of Judge Judy, I'm not gonna lie), has taught me to never loan money to family and friends. I just make it a gift, and if they decide to give you any money in the future, well that's nice. But if you've psychologically counted the money as a loan, and the person can't or doesn't pay, you've got not only a serious financial problem, but also a serious relationship problem. It can destroy your respect for that person and drive a massive wedge between you.

Yes, the risks in loaning money to friends and family seem enormous.  You risk far more than the money.

From what I understand, an enormous number of business ventures are funded this way, though.  I guess people don't tend to worry about these risks as much as I do...?  (Edit: Sorry if that sounds like I am discouraging you, TennPaGa.  This is only my own reasoning on why I never lend money to or seek money from friends and family.)

[Gumby]

Gumby,

Does the cheese represent interest, or payment of principal in full?

Seems like when you get money for cheese that's a sale like any other.

In this particular crowdfunding scheme, the donors never expected to see their money again. It wasn't really supposed to be a loan or an investment. More like a donation. I guess the cheese was just supposed to be a gift for donating money to their business plan. I would have preferred if they just asked for donations and didn't promise any gifts.

[atrchi]

What's she going to do with the $4K? Is the business going to have a location or is it all virtual / home-based? If there's going to be a store, perhaps you could settle for the location rights in exchange for the $4K. That way if the business goes nowhere, you lose your money but no feelings are hurt. On the other hand if the business takes off, the location rights could be worth much more than $4K eventually. It could be decades before you can cash out.

[Greg]

her current employer (nothing to do with baking) asked "what will it take to keep you", and she told them, and they gave it to her.

If only I had a nickel for every time I heard that... I'd have exactly zero nickels. Good for her.